China's new foreign exchange controls create fresh concerns. September 2017

Transcription

1 China's new foreign exchange controls create fresh concerns September 2017

2 Contents Background 1 Current account v capital account transactions 1 Why has China imposed the new controls? 1 What do the new policies say? 1 Conclusion 4

3 China's new foreign exchange controls create fresh concerns September China's new foreign exchange controls create fresh concerns Background Foreign investors and other parties transacting with Chinese counterparts who were still digesting the events of the last two years during which China appeared to be moving towards a more inward-looking approach, with the promulgation of, among others, the People's Republic of China Counter-Terrorism Law, the People's Republic of China National Security Law and more recently the People's Republic of China Cybersecurity Law, are now facing a new set of challenges. China has recently imposed a series of foreign exchange controls which affect all deals done involving currency outflows from China, notably outbound investments by Chinese buyers. Current account v capital account transactions China divides transactions involving a crossborder element into: current account transactions which are liberalized and only require proof to be provided to the remitting and converting or receiving bank in China that there is a genuine and lawful underlying transaction; and capital account transactions which are still restricted and more strictly regulated. Why has China imposed the new controls? There is currently a heightened sensitivity in China in relation to outflows of capital, with the authorities having very recently issued a series of policies to restrict these. This suggests that Chinese individuals and companies may have been trying to shift their money out of China in significant amounts in recent years as the growth curve and future growth prospects for the Chinese economy have weakened. Amongst other methods, it is known that one such route for shifting assets overseas involved fake transactions conducted via Hong Kong using dummy companies, e.g. setting up a shell company in Hong Kong and invoicing exports to China that were never delivered. It is not clear to what extent these structures were more motivated by individuals seeking to repatriate funds overseas as opposed to corporates. Leaving aside the issue of the underlying fraud, these would constitute current account transactions. Eventually the Chinese authorities became aware of this through discrepancies in the relevant records, leading to increased scrutiny with regard to capital outflow transactions. More recently concerns have been raised about questionable outbound transactions being used by Chinese companies and individuals to shift assets overseas. These, on the other hand, are capital account transactions. They are particularly sensitive and significant to China's regulators because of the potential to shift large amounts overseas in a single transaction. What do the new policies say? China issued a series of policies introducing the new procedures in the period running up to the end of 2016, through pronouncements by various government agencies, rather than hard law. In November 2016, the central planning body and key outbound investment approval agency, the National Development and Reform Commission ("NDRC") issued an internal note on restricting certain outbound capital account transactions. These are scheduled to expire in September Based on such NDRC note, up to the end of September 2017, the following categories of outbound transactions will, in particular, be targeted by the Chinese authorities and will not be granted approvals to proceed in principle unless otherwise specifically permitted by the relevant authorities

4 2 Hogan Lovells (based on criteria which are not in the public domain): outbound investments in real estate made by State-owned enterprises with a Chinese investment amount of USD 1 billion or more; overseas investments involving an extralarge Chinese investment amount exceeding USD 10 billion; outbound transactions outside the core business of the company involving an amount of USD 1 billion or more; outbound investments directly made by limited partnerships; foreign direct investment involving an acquisition of 10% or less of the shares in an overseas listed company; investments in offshore targets that have an asset value that is larger than the Chinese acquirer; investments in offshore targets where the investing entity is a newlyestablished vehicle; or transactions involving domestic capital participation in the delisting of overseas listed Chinese enterprises. In addition, outbound investments made by Chinese enterprises with a high asset-liability ratio and low net assets yield will be monitored closely as well. It has been widely reported that on 28 November 2016, the Shanghai Branch of the State Administration of Foreign Exchange ("SAFE") held an internal meeting with regard to the administration of cross-border receipts and payments. It was reported that as a result of this and the internal guidance to banks issued on the back of this, any single purchase or payment of foreign exchange and RMB/foreign currency disbursement in an amount equivalent to or greater than USD 5 million for capital account transactions must be first reported to the Beijing SAFE as a large transaction. Such transactions may now only be carried out once the relevant authorities, including the People's Bank of China ("PBOC"), SAFE, NDRC, Ministry of Commerce ("MOFCOM") and so forth, have completed an authenticity and compliance review of the transaction and granted approval therefor. If the transaction amount exceeds USD 50 million (inclusive), a stricter level of scrutiny applies, involving direct monitoring by central SAFE in the system and a review. Shanghai SAFE also emphasized that transactions must not be split up into smaller components in order to circumvent large amount transaction reporting. On 6 December 2016, NDRC, MOFCOM, PBOC and SAFE jointly held a press release responding to the media inquiries regarding outbound investment administration. Based on the official responses during the press release, going forwards, the Chinese authorities will pay particular attention to the following outbound investment transactions, meaning such investments will to subject to greater administrative scrutiny as compared to others: large investments in business outside the core business of the Chinese investor; outbound investments made by limited partnerships; investment in offshore targets that have asset values that are larger than the Chinese acquirers; the investing entity is a newly established vehicle [without any substantial operations]; and irrational overseas investments in certain industries, specifically real estate, hotels, film, entertainment and sports clubs.

5 China's new foreign exchange controls create fresh concerns September On 18 August 2017, General Office of the State Council issued the Circular of the General Office of the State Council on Forwarding the Guiding Opinions of the NDRC, MOFCOM, PBOC and the Ministry of Foreign Affairs on Further Guiding and Regulating the Direction of Outbound Investments ("Outbound Investment Guidelines"). In the Outbound Investment Guidelines, in a move that mirrors the classification for foreign direct investments in China, the Guidance Catalogue for Foreign Investment Industries, the latest iteration of which took effect on 28 July 2017 (the "Catalogue") outbound investments are divided into three categories: "encouraged", "restricted" and "prohibited". Encouraged outbound investments include: outbound investments in infrastructure which are advantageous to progressing the Belt and Road Initiative and are interconnected with the surrounding infrastructure; outbound investments that mobilize the export of superior domestic capacity, high-quality equipment and technical standards; outbound investments that strengthen investment partnerships with hi-tech and cutting-edge manufacturers overseas, and outbound investment in research and development centers abroad; outbound investments in the offshore exploration, prospecting and development of oil, gas, mineral products and other such energy resources, provided that the domestic investors prudently assess the economic benefits thereof; outbound investments in the agricultural industry, and in mutually beneficial investment partnerships in the farming, forestry, animal husbandry, side-line production and fishery sectors; outbound investments in the trade, cultural, logistics and other service sectors that are carried out in an orderly manner; and qualified financial institutions will be supported in establishing branch institutions and service networks overseas which conduct compliant business activities in accordance with law. Restricted outbound investments include: outbound investments in countries or regions with which China has no diplomatic relations, warzones or sensitive countries or regions subject to restrictions under bilateral treaties or agreements entered into by China; outbound investments in real estate, hotels, movie theaters, entertainment industries, sports clubs and so forth; outbound investments in setting up equity investment funds or investment platforms which have no actual industrial projects overseas; outbound investments using obsolete production equipment which does not meet the technical standards or requirements of the investment destination country; and outbound investments which fail to meet the environmental protection, energy consumption and safety standards of the investment destination country. Projects in the first three areas under the category "restricted outbound investment" will be subject to NDRC approval, which is likely to be difficult to obtain. Prohibited outbound investments include:

6 4 Hogan Lovells outbound investments involving the export of core military industry technology and products absent the approval of the State; outbound investments which use technology, processes or products prohibited by China from export; outbound investments in gambling, pornography and other such industries; outbound investments which are prohibited under international treaties concluded or acceded to by China; and other outbound investments which jeopardize or may jeopardize the interests of the State and/or national security. Although the Outbound Investment Guidelines give a relatively clear picture of which category certain proposed outbound investments will be classified into, there is still plenty of room for argument and ambiguity e.g. what is 'superior domestic capacity' and concerns over whether this means China is actually encouraging enterprises in China to export its over capacity. Many key questions remain: unanswered: what is the position of all the other sectors which are not mentioned? Do they (in the same way as the "permitted" sectors which are not set out in the Catalogue) form a class of "permitted" sectors for outbound investments? Will "encouraged" projects jump the queue in terms of getting money out of China? Above all, the Outbound Investment Guidelines do nothing to clarify the opaque underlying review processes and do not give any guidance on timing for completing these, which are already causing Chinese buyers to default under their payment obligations in outbound investments and resurrection of the so-called 'China premium' due to the lack of 'completion certainty' in transactions involving Chinese buyers. Conclusion In general, what is clear from anecdotal and our experience with actual client transactions is that payments out of China on outbound transactions are being subjected to far greater scrutiny as compared to say 6 months or a year ago. Summarising all the policy pronouncements so far, the levels of scrutiny on any outbound capital account transactions will depend on: the nature and industry sector of the target; the amount of money that is being transferred overseas; the country to which the payment will be transferred; and the profile of the Chinese investor (e.g. newly established SPV and/or acting outside its core business). The new review procedures are somewhat opaque. Timing for completing the regulatory procedures for outbound direct investments remains highly uncertain and unpredictable, even after we have seen the first few cases go through the new system. Some transactions in "restricted" sectors have very visibly blown up recently. What is clear is that extra time needs to be factored into payment deadlines for all transactions involving outbound payments from China, as the new review process is likely to cause delays of up to several months in our experience. Even the approval of the transfer of small amounts of money (less than USD 10 million) may take up to one month. In addition, based on our enquiries with local banks, currently PBOC grants an unofficial "quota" to each bank requiring the total capital outflow amount processed by the specific bank

7 China's new foreign exchange controls create fresh concerns September per month to be within the "quota" limits. This "quota" would apply to all capital outflows from China, even including payments under current account transactions (e.g. cross-border trading transactions) which, as noted above, are less highly regulated than capital account transactions. Transactions at month end are likely to be pushed into the next month due to quotas being used up. Good relationships with the relevant authorities and government officials will likely be crucial for getting larger transactions approved in a timely fashion, and we expect that many more interactions will be needed to explain the rationale of certain transactions to regulators. Application documents for outbound approvals should include facts and evidence as to the genuine nature and business rationale for transactions (e.g. why is the target selling the asset and how the acquisition fits into the Chinese acquirer's strategy), so that any concerns in this regard from the regulatory stakeholders can be addressed at an early stage. China will also be well aware of the cases where fraud was not involved but where Chinese companies going outbound (particularly but not exclusively State-owned Enterprises) overpaid or made overseas investments that did not stack up commercially: it may also be using the new reviews and controls to bring order to the market and to weed these out in the process, thereby preventing State-owned assets from being dissipated in ill-thought-through overseas forays. China is clearly also saying that what it perceives as non-essential, non-value-creating investments in certain relatively risky sectors or fund or pooled investments that do not have any specific projects in mind will henceforth be unlikely to proceed, while policy-driven overseas investments e.g. around the Belt and Road Initiative will be pushed through. This is clearly an area to watch as the new reviews are rolled out: we understand that the new policies create uncertainty and concerns for many transaction counterparties, particularly sellers to Chinese buyers. We are available to talk through the issues and share our experiences. These policies do not change the fact that many Chinese companies remain over-exposed to the domestic market and will continue to seek to spread risks over different markets to reduce the impact of events affecting that market as well as new technologies and overseas distribution: China's appetite for locking in oil, gas and mineral resources overseas remains undiminished, hence the classification in the "encouraged" category under the Outbound Investment Guidelines. We remain, therefore, firmly of the view that this is not in any way the 'end of the China outbound story' as some have predicted: we take the view that this is only a "bump in the road" and that where there is a genuine outbound deal that makes business and strategic sense, it will still get approval/record filing and the deal will go ahead, even if the timetable stretches out somewhat. What it does mean is that sellers will need to ascertain the categorisation early on to inform their decisions, arm themselves with reserves of patience, and manage payment expectations of internal stakeholders when the inevitable delay materialises.

8 6 Hogan Lovells Contacts Andrew McGinty Partner, Shanghai Jun Wei Partner, Beijing Liang Xu Partner, Beijing

9 Alicante Amsterdam Baltimore Beijing Brussels Budapest Caracas Colorado Springs Denver Dubai Dusseldorf Frankfurt Hamburg Hanoi Ho Chi Minh City Hong Kong Houston Jakarta Johannesburg London Los Angeles Louisville Luxembourg Madrid Mexico City Miami Milan Minneapolis Monterrey Moscow Munich New York Northern Virginia Paris Perth Philadelphia Rio de Janeiro Rome San Francisco São Paulo Shanghai Shanghai FTZ Silicon Valley Singapore Sydney Tokyo Ulaanbaatar Warsaw Washington, D.C. Zagreb Our offices Associated offices "Hogan Lovells" or the "firm" is an international legal practice that includes Hogan Lovells International LLP, Hogan Lovells US LLP and their affiliated businesses. The word "partner" is used to describe a partner or member of Hogan Lovells International LLP, Hogan Lovells US LLP or any of their affiliated entities or any employee or consultant with equivalent standing. Certain individuals, who are designated as partners, but who are not members of Hogan Lovells International LLP, do not hold qualifications equivalent to members. For more information about Hogan Lovells, the partners and their qualifications, see Where case studies are included, results achieved do not guarantee similar outcomes for other clients. Attorney advertising. Images of people may feature current or former lawyers and employees at Hogan Lovells or models not connected with the firm. Hogan Lovells All rights reserved.